Summary of KAYDON CORP - Yahoo! Finance

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
Our Company, Kaydon Corporation, is a leading designer and manufacturer of custom-engineered, performance-critical products, supplying a broad and diverse group of alternative-energy, industrial, aerospace, medical and electronic equipment, and aftermarket customers. Demand for our products depends, in part, upon a wide range of general economic conditions, which affect our markets in varying ways from quarter to quarter. The global recessionary conditions that impacted the economy during the second half of 2008 continued during the first three quarters of 2009, reducing demand for our products and resulting in year-to-date sales volume declines in each of our businesses. The adverse macroeconomic conditions have resulted in customers continuing to act with caution, resulting in a decline in orders and requests for deferred delivery. While worldwide business conditions remain very challenging, there has been anecdotal evidence that economic conditions are stabilizing, albeit at cyclically low levels. We believe these challenging economic conditions will likely continue through the remainder of 2009, which will continue to negatively impact end-user spending and our customers' demand for our products. Because of our diverse product offerings and served markets, as well as the general uncertainty as to the timing and nature of any economic recovery, the specific impact of these economic conditions on our operating results is difficult to predict.
With respect to the wind energy market, while the third quarter 2009 reflected sequential and year-over-year quarterly growth, it is important to note that the longer term outlook will be heavily influenced by government policy. Recent actions and policy statements regarding a sustained, committed policy towards increasing renewable energy usage in the United States supports the confidence we have in our investment in this market.
At October 3, 2009, our current ratio was 8.4 to 1 and working capital totaled $382.2 million. We believe that our current cash and cash equivalent balance of $247.8 million at October 3, 2009, and future cash flows from operations, along with our borrowing capacity are adequate to fund our strategies for future growth, including working capital, expenditures for capital expansion and efficiencies, selected stock repurchases, market share initiatives and corporate development efforts.
In summary, our future performance will be impacted by general economic conditions, the strength or weakness of the manufacturing environment, the success of our efforts to continue to expand operations and improve operating efficiencies, as well as the use of available cash and borrowing capacity for future acquisitions.
The discussion that follows should be read in conjunction with the unaudited Consolidated Condensed Financial Statements (and the Notes thereto), included elsewhere in this report, and our 2008 Annual Report on Form 10-K, particularly "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," to assist in understanding our results of operations, our financial position, cash flows, capital structure and other relevant financial information.

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Results of Operations
The discussion that follows describes the significant factors contributing to
the changes in our results of operations for the periods presented.
Third Quarter Results

                                                             For the third quarter ended
                                                 October 3,       % of      September 27,      % of
Dollars in millions, except per share amounts       2009         Sales          2008          Sales

Net sales                                        $    123.6                 $      126.8
Cost of sales                                          85.6                         82.3

Gross profit                                           38.0       30.8 %            44.5       35.1 %
Selling, general and administrative expenses           13.4       10.9 %            19.7       15.6 %

Operating income                                       24.6       19.9 %            24.8       19.5 %
Interest, net                                           0.2                          0.1

Income before income taxes                             24.8                         24.9
Provision for income taxes                              8.7                          8.6

Net income                                       $     16.1                 $       16.3

Earnings per share:
Basic                                            $     0.48                 $       0.54

Diluted                                          $     0.48                 $       0.50

Net sales for the third quarter of 2009 decreased $3.2 million, or 2.5 percent, compared to the third quarter of 2008. During the third quarter of 2009, price declines aggregating $2.8 million and the effects of adverse currency exchange rate changes of $1.5 million more than offset increased sales attributable to increased volumes of $1.2 million. Price declines were primarily attributable to contractual adjustments associated with the pass-through of lower material costs. The effects of unfavorable currency exchange rate changes were principally attributable to a stronger U.S. dollar relative to the Euro and British pound. Sales growth attributable to increased volumes was $1.2 million as a $22.6 million volume increase to wind energy customers offset $21.4 million in volume decreases across the rest of our end markets, especially industrial markets, as a result of the global economic slowdown. Wind energy sales in the third quarter of 2009 were $41.0 million, an increase of $19.4 million or 90 percent, compared to the third quarter of 2008, as the improved volume significantly exceeded the impact of the aforementioned contractual pricing adjustments.
Gross margin in the third quarter of 2009 was 30.8 percent, a decrease of 4.3 points from the 35.1 percent gross margin in the third quarter of 2008. Unfavorable changes in product mix accounted for 1.7 points of the decline as the volume increase to wind energy customers was largely offset by volume decreases to industrial markets, which command higher margins. Pricing had an insignificant impact on gross margin as price reductions were largely offset by material cost reductions. The remaining 2.6 points of the gross margin difference is attributable to higher unabsorbed fixed costs associated with lower production volumes, as inventory increased in the third quarter of 2008 and decreased in the third quarter of 2009, partially offset by net cost reductions.
Selling, general and administrative expenses were $13.4 million, or 10.9 percent of sales, in the third quarter of 2009, compared to $19.7 million, or 15.6 percent of sales, in the third quarter of 2008. During the third quarter of 2009, we recorded curtailment gains totaling $5.4 million that were associated with changes to certain postretirement benefit plans. The remaining decrease is primarily attributable to the preemptive and continuing steps we have taken to reduce discretionary costs.
Our operating income was $24.6 million in the third quarter of 2009 compared to $24.8 million in the third quarter of 2008, as the decrease in gross profit more than offset the decline in selling, general and administrative expenses. During the third quarter of 2009, interest income totaled $0.2 million on average investment balances of $223.0 million. This compares to $1.5 million of interest income in last year's third quarter when we earned approximately 2.2 percent on average investment balances of $269.2 million. The decrease in average investment balances resulted from investments in our capital expenditure program, increased working capital, contributions to our qualified pension plans, the use of cash for our stock repurchase program, and an increase in our dividend rate. The

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significantly lower interest earned in the third quarter of 2009 reflects prevailing historically low interest rates on short term treasury securities. The effective tax rate for the third quarter of 2009 was 35.1 percent, slightly higher than the 34.4 percent effective tax rate for the third quarter of 2008. The third quarter 2009 effective tax rate was unfavorably impacted by a decrease in foreign earnings which are subject to lower tax rates than the U.S. statutory rate of 35.0 percent. The full year 2009 effective tax rate is expected to be approximately 35.4 percent.
Net income for the third quarter of 2009 was $16.1 million or $0.48 per share on a diluted basis compared to net income for the third quarter of 2008 of $16.3 million, or $0.50 per share on a diluted basis. Third quarter 2008 results have been adjusted to reflect the required retrospective application of new accounting guidance related to earnings per share which was effective January 1, 2009. This required adjustment reduced previously reported third quarter 2008 basic earnings per share by $0.01 and had no effect on diluted earnings per share.

First Three Quarters Results

                                                          For the first three quarters ended
                                                 October 3,       % of       September 27,      % of
Dollars in millions, except per share amounts       2009          Sales          2008          Sales

Net sales                                        $  332.3                    $      390.0
Cost of sales                                       226.1                           244.0

Gross profit                                        106.2          32.0 %           146.0       37.4 %
Selling, general and administrative expenses         52.8          15.9 %            62.9       16.1 %

Operating income                                     53.4          16.1 %            83.1       21.3 %
Interest, net                                         0.2                            (4.1 )

Income before income taxes                           53.6                            79.0
Provision for income taxes                           19.0                            27.7

Net income                                       $   34.6                    $       51.3

Earnings per share:
Basic                                            $   1.03                    $       1.80

Diluted                                          $   1.03                    $       1.65

Net sales for the first three quarters of 2009 equaled $332.3 million, a decrease of 14.8 percent, compared with the same period of 2008. Sales declines for the first three quarters of 2009 attributable to reduced volumes totaled $51.1 million, or 13.1 percent, compared to the first three quarters of 2008 as $75.7 million in volume decreases across our non-wind end markets, principally industrial markets, more than offset higher sales associated with a $24.6 million increase in volume to wind energy customers. Improved pricing yielded an increase of $3.1 million and was primarily attributable to price increases on our core products, and to a lesser extent, contractual adjustments associated with the pass-through of material cost changes on a year-to-date basis. Finally, the adverse effects of currency exchange rate changes had a $9.7 million, or 2.5 percent, unfavorable impact on sales. This decrease was principally attributable to a stronger U.S. dollar relative to the Euro and British Pound on a year-over-year basis.
Wind energy sales in the first three quarters of 2009, were $81.7 million, an increase of $25.2 million, or 45 percent compared to the first three quarters of 2008. The increase was principally attributable to improved volumes. From a regional perspective, our businesses serving international markets, principally Europe, continued to experience declines during the first three quarters of 2009 similar to those previously experienced in our domestic end markets.
Gross margin in the first three quarters of 2009 was 32.0 percent compared with 37.4 percent in the first three quarters of 2008. The year-over-year decrease of 5.4 points is attributable to decreased sales volume and higher unit costs associated with lower production volumes of 4.8 points, and adverse changes in product mix, largely due to sales declines in higher margin industrial segments of 1.2 points, partially offset by favorable pricing.
Selling, general and administrative expenses were $52.8 million, or 15.9 percent of sales, in the first three quarters of 2009, compared to $62.9 million, or 16.1 percent of sales in the first three quarters of 2008. During the first three quarters of 2009, we recorded curtailment gains totaling $6.3 million that were associated with changes to certain postretirement benefit plans. The remainder of the year-over-year decrease is primarily attributable to the

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preemptive and continuing steps we have taken to reduce discretionary costs, partially offset by approximately $1 million of one-time expenses associated with layoffs and severance in 2009.
Our operating income was $53.4 million in the first three quarters of 2009 compared to $83.1 million in the first three quarters of 2008, as the decrease in gross profit of $39.8 million more than offset the reduction in selling, general and administrative expenses of $10.1 million.
During the first three quarters of 2009, interest income totaled $0.4 million on average investment balances of $218.6 million. This compares to $5.2 million of interest income in last year's first three quarters when we earned approximately 2.5 percent on average investment balances of $279.9 million. The decline in average investment balances resulted from our capital expenditure program, increased working capital, our stock repurchase program, contributions to our qualified pension plans and an increase in our dividend rate. In addition to lower average balances, the significantly lower interest earned in the first three quarters of 2009 reflects prevailing historically low interest rates on short term treasury securities.
During the first three quarters of 2009, interest expense totaled $0.2 million and represented amortization of costs associated with the credit facility. During the first three quarters of 2008, interest expense totaled $9.3 million. The year-over-year difference of $9.1 million is attributable to interest and amortization of issuance costs associated with the Notes that were outstanding in the prior year.
The effective tax rate for the first three quarters of 2009 was 35.6 percent. The effective tax rate for the first three quarters of 2008 was 35.1 percent. Net income for the first three quarters of 2009 was $34.6 million, or $1.03 per share on a diluted basis, compared to the adjusted net income for the first three quarters of 2008 of $51.3 million, or $1.65 per share on a diluted basis. The first three quarters 2008 results have been adjusted to reflect the required retrospective application of new accounting guidance related to convertible debt and earnings per share, which were effective January 1, 2009, resulting in the recording of additional non-cash interest expense of $3.1 million, $2.0 million net of tax. These required adjustments reduced previously reported first three quarters 2008 basic earnings per share by $0.10 and diluted earnings per share by $0.02.
Results of Business Segments
We classify our businesses into three reporting segments: Friction Control Products, Velocity Control Products, and Sealing Products. Our remaining operating segments are combined and disclosed as "Other businesses." The segment discussions that follow describe the significant factors contributing to the changes in results for each segment.
The aforementioned 2009 curtailment gains resulting from changes to our postretirement benefit plans, which total $5.4 million in the third quarter 2009 and $6.3 million for the first three quarters 2009, were not allocated to our operating segments.
Friction Control Products

                              For the third quarter ended                 For the first three quarters ended
                       October 3,      September 27,        %         October 3,       September 27,         %
Dollars in millions       2009             2008          Change          2009               2008           Change

Sales                  $   87.1          $     79.3        9.9 %     $    223.5         $      240.2        (6.9 )%
Operating Income       $   15.4          $     16.4       (6.3 )%    $     37.6         $       56.1       (33.0 )%
Operating Margin           17.7 %              20.7 %                      16.8 %               23.4 %

Sales in our Friction Control Products reporting segment increased $7.8 million or a 9.9 percent compared to the prior third quarter. The sales increase was driven by a $19.4 million increase in sales to wind energy customers. During the 2009 period, there was an improvement in trade credit conditions, which benefited shipments, as our customers' ability to obtain letters of credit improved. The sales gains to wind energy customers offset an $11.6 million decline in sales principally to our industrial and government markets. Overall, sales were reduced by a $0.9 million unfavorable year-over-year effect of currency exchange rate changes.

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Operating income from our Friction Control Products reporting segment during the third quarter of 2009 was $15.4 million compared to $16.4 million in the third quarter of 2008. The $1.0 million decrease was principally attributable to the adverse effect of changes in product mix of $2.1 million resulting from increased sales to wind energy customers being largely offset by volume decreases to industrial markets, which command higher margins. This decrease was partially offset by cost decreases net of higher costs associated with lower production volumes, as the combined effect of inventory increases in the third quarter of 2008 and decreases in the third quarter of 2009 more than offset the increase in sales volume.
The third quarter of 2009 reflected sequential sales growth in our wind energy and medical markets and a solid position in our military market. While we are pleased with our current position in these markets, considering the current economic environment, their longer-term outlooks will be heavily influenced by government policy issues including clear, long-term support for renewable energy initiatives and funding for military spending. Industrial markets appear to have stabilized at the relatively low levels noted in the second quarter of 2009. Sales in our Friction Control Products reporting segment were $223.5 million during the first three quarters of 2009 compared to $240.2 million in the first three quarters of 2008, reflecting a decrease of $16.7 million or 6.9 percent. Excluding sales gains to wind energy customers of $25.2 million, sales to all other markets in the first three quarters of 2009 decreased by $41.9 million from the comparable period last year. This decline was due to the effects of volume declines of $38.7 million and the adverse effects of currency exchange rate changes of $5.4 million, which were only partially offset by a $2.2 million effect of increased pricing.
Operating income from the Friction Control Products reporting segment during the first three quarters of 2009 totaled $37.6 million compared to $56.1 million in the first three quarters of 2008. The $18.5 million decrease in operating income was due to a $14.9 million adverse effect of lower sales volumes and lower production volumes, a $2.8 million adverse effect of product mix resulting from lower sales to higher margin industrial markets, with the remaining $0.8 million of the decrease resulting from higher costs net of pricing gains. The higher costs include increased depreciation associated with our investment in capacity to support the wind energy growth initiative, increased pension expense, and severance and redundancy costs incurred during the first three quarters of 2009. Velocity Control Products

                              For the third quarter ended                  For the first three quarters ended
                       October 3,      September 27,        %         October 3,       September 27,          %
Dollars in millions       2009             2008           Change         2009               2008            Change

Sales                   $  12.2          $     17.1       (28.7 )%    $    34.6         $      55.8         (38.0 )%
Operating Income        $   2.1          $      4.5       (53.0 )%    $     5.2         $      16.2         (68.0 )%
Operating Margin           17.4 %              26.4 %                      15.0 %              29.0 %

In the third quarter of 2009, sales in our Velocity Control Products reporting segment were $12.2 million compared to $17.1 million in the third quarter of 2008. The decrease of $4.9 million was attributable to volume declines of $4.2 million caused by reduced domestic and international economic demand, especially in industrial markets, and the adverse effects of currency exchange rate changes of $0.7 million.
The Velocity Control Products reporting segment contributed $2.1 million to our operating income during the third quarter of 2009 compared to $4.5 million during the comparable period last year. This decrease in operating income was principally due to the effects of the decline in sales volumes mentioned above. During the first three quarters of 2009, sales in our Velocity Control Products reporting segment were $34.6 million compared to $55.8 million in the first three quarters of 2008. The decrease of $21.2 million was due to reduced volumes of $17.0 million caused by decreased demand in domestic and international markets, especially industrial markets, and the adverse effects of currency exchange rate changes of approximately $4.2 million.
The Velocity Control Products reporting segment contributed $5.2 million to our operating income during the first three quarters of 2009 compared to $16.2 million during the comparable period last year. This decrease in operating income is principally due to the effect of the decline in sales volume mentioned above.

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Sealing Products

                              For the third quarter ended                  For the first three quarters ended

                       October 3,      September 27,        %         October 3,       September 27,          %
Dollars in millions       2009             2008           Change         2009               2008            Change

Sales                   $   8.8         $      10.8       (18.1 )%    $    29.0         $      34.0         (14.7 )%
Operating Income        $   0.8         $       1.0       (14.6 )%    $     2.2         $       4.0         (45.2 )%
Operating Margin            9.6 %               9.2 %                       7.6 %              11.9 %

Sales in our Sealing Products reporting segment in the third quarter of 2009 were $8.8 million compared to $10.8 million in the third quarter of 2008. The $2.0 million sales decline was principally attributable to decreased sales volumes resulting from the delay of capital projects which is continuing to cause our customers to defer the delivery of our product, and soft industrial markets, particularly the railroad and hydrocarbon processing markets. The Sealing Products reporting segment contributed $0.8 million to our operating income during the third quarter of 2009 compared to $1.0 million during the comparable period last year. The $0.2 million decrease is attributable to the effect of lower sales volume of $1.0 million partially offset by $0.8 million of net cost reductions.
Sales in our Sealing Products reporting segment in the first three quarters of 2009 were $29.0 million compared to $34.0 million in the first three quarters of 2008, as decreased volume associated with the global economic recession of $5.6 million was only partially offset by a $0.6 million increase resulting from favorable pricing.
The Sealing Products reporting segment contributed $2.2 million to our operating income during the first three quarters of 2009 compared to $4.0 million during the comparable period last year. The combined effect of the decreased sales volume mentioned above and adverse changes in product mix associated with proportionately lower sales of higher margin industrial seals totaled $3.7 million, and were partially offset by the impact of higher pricing of $0.6 million, and net cost reductions of approximately $1.3 million.

Other businesses

                              For the third quarter ended                  For the first three quarters ended

                       October 3,      September 27,        %         October 3,       September 27,          %
Dollars in millions       2009             2008           Change         2009               2008            Change

Sales                   $  15.5          $     19.7       (21.0 )%    $    45.2         $      60.0         (24.7 )%
Operating Income        $   1.4          $      1.8       (25.2 )%    $     3.3         $       7.3         (55.4 )%
Operating Margin            8.9 %               9.4 %                       7.2 %              12.2 %

Sales in our other businesses were $15.5 million in the third quarter of 2009 compared to $19.7 million in the third quarter of 2008. The $4.2 million sales decline was principally due to the global economic slowdown which resulted in decreased sales of our liquid filtration, air filtration, metal alloy, and metal-forming products. We expect these markets to continue at these decreased demand levels for the remainder of 2009.
Our other businesses contributed $1.4 million to our operating income during the third quarter of 2009 compared to $1.8 million during the comparable period last year. The $0.4 million decrease is attributable to the effect of lower sales volume of $1.9 million, partially offset by $1.4 million in net favorable material costs and reduced spending.
Sales in our other businesses were $45.2 million during the first three quarters of 2009 compared to $60.0 million in the first three quarters of 2008. The $14.8 million sales decline was principally due to the global economic recession which resulted in decreased sales of our liquid filtration, air filtration, metal alloy, and metal-forming products.
Our other businesses contributed $3.3 million to our operating income during the first three quarters of 2009 compared to $7.3 million during the comparable period last year. This decrease in operating income is due to the effect of lower sales volumes of $6.4 million, partially offset by a net cost decrease of $2.4 million.

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Liquidity and Capital Resources
At October 3, 2009, our current ratio was 8.4 to 1 and working capital totaled $382.2 million, including $247.8 million of cash and cash equivalents. At December 31, 2008, our current ratio was 6.8 to 1 and working capital totaled $365.3 million, including cash and cash equivalents of $233.0 million. Net cash from operating activities during the first three quarters of 2009 equaled $44.1 million, compared to net cash from operating activities of $49.7 million during the first three quarters of 2008. The year-over-year decline in net cash from operating activities was principally due to the decline . . .